Morningstar, Inc. — 2018 Second-Quarter Form 10-Q Summary
Business context and reporting period
Morningstar provides subscription and license-based data and research products, asset-based investment management and advisory services, and transaction-based products including credit ratings, advertising, and conferences. The filing covers the three and six months ended June 30, 2018, and is unaudited. Morningstar reports one operating segment.
Key financial metrics
| Metric | Three months ended June 30, 2018 | Year-over-year change | Six months ended June 30, 2018 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $252.4 million | 10.1% | $495.9 million | 13.0% |
| Operating income | $53.6 million | 16.6% | $101.1 million | 35.9% |
| Operating margin | 21.2% | Up 1.2 percentage points | 20.4% | Up 3.4 percentage points |
| Net income | $41.8 million | Down from $46.1 million | $83.7 million | Up from $64.1 million |
| Diluted EPS | $0.97 | Down from $1.07 | $1.95 | Up from $1.49 |
| Cash flow from operations | $69.8 million | 25.3% | $129.7 million | 26.9% |
| Free cash flow | $51.8 million | 41.1% | $94.1 million | 36.6% |
Revenue by type for the first six months was $362.9 million license-based, $99.4 million asset-based, and $33.6 million transaction-based. PitchBook Data, Morningstar Data, Morningstar Direct, Morningstar Managed Portfolios, and Morningstar Credit Ratings were key growth contributors.
As of June 30, 2018, cash and cash equivalents were $307.1 million, investments were $44.8 million, and total liquidity including cash, cash equivalents, and investments was $351.9 million. Long-term debt was $125.0 million under a $300.0 million credit facility, leaving $175.0 million available. The company was in compliance with its financial covenants. Total assets were $1.427 billion and total equity was $871.4 million.
Material changes versus the prior comparable period
- Six-month revenue growth was broad-based: license-based revenue increased 12.2%, asset-based revenue increased 13.2%, and transaction-based revenue increased 22.2%.
- PitchBook Data revenue increased 58.6% for the first six months, while Morningstar Direct revenue increased 13.9% and Morningstar Data revenue increased 12.8%.
- International revenue increased 20.1% for the first six months and represented approximately 26% of consolidated revenue, compared with 24% in the prior-year period. Foreign currency translation increased revenue by approximately $8.4 million.
- Operating leverage improved as total operating expense grew 8.4%, below the 13.0% revenue growth rate. Cost of revenue declined to 40.8% of revenue from 43.8%.
- Second-quarter net income and diluted EPS declined because the second quarter of 2017 included a $17.5 million gain on the sale of HelloWallet. The first six months of 2018 included a $10.5 million gain on the sale of the 15(c) board consulting services product line.
- Cash declined by $1.1 million during the first six months after $55.0 million of debt repayment, $35.6 million of capital expenditures, $21.3 million of dividends, and $10.8 million of share repurchases.
- Morningstar adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method. The adoption increased reported revenue by $1.6 million in the second quarter and $3.3 million in the first six months, with a $17.0 million increase to opening retained earnings related primarily to deferred sales commissions.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide formal numerical revenue or earnings guidance. Management expects available cash, investments, operating cash flow, and the credit facility to fund operating and cash needs for at least the next 12 months. Capital expenditures are expected to continue in 2018, including spending on internally developed software, hardware, and office improvements. Morningstar is migrating infrastructure to the cloud over several years, which may temporarily affect capital expenditures and operating expenses.
Management is shifting away from customized institutional asset management toward the more scalable and higher-margin Managed Portfolios offering. Assets under management and advisement for Managed Portfolios increased 27.7% year over year, while institutional asset management assets declined 69.9% because of planned client and product changes. Average assets under management and advisement declined 3.0% in the second quarter and 2.8% for the first six months.
- Market volatility, declining fixed-income markets, and asset-based fee exposure may affect revenue and assets under management.
- Industry migration toward passive, lower-cost investment products may pressure asset-management clients and spending.
- Key risks include fiduciary and regulatory liability, data or privacy breaches, technology outages and cloud migration, cybersecurity and intellectual-property issues, foreign operations, currency fluctuations, acquisitions and investments, and employee retention.
- Approximately 77% of cash, cash equivalents, and investments were held outside the United States, creating foreign-currency and repatriation considerations.
- The company has not hedged foreign-currency exposure. A 10% adverse currency movement was estimated to reduce equity by approximately $32.5 million across disclosed currency positions.
- A putative class-action RICO complaint was amended after the initial complaint was dismissed without prejudice. Morningstar moved to dismiss the amended complaint, which was awaiting a court ruling; the company could not predict the outcome.
- The company had $14.7 million of gross unrecognized tax benefits at June 30, 2018. The ultimate effect of the 2017 Tax Reform Act remained subject to continuing analysis, including the accounting treatment of GILTI taxes.
Most important facts for investors to verify
- Whether PitchBook, Morningstar Direct, Morningstar Data, and Managed Portfolios sustain their reported growth and renewal trends.
- The effect of ASC Topic 606, including gross presentation of third-party content and capitalization and amortization of sales commissions, on future revenue and margins.
- Progress and costs associated with the multi-year cloud infrastructure migration.
- Changes in assets under management and advisement, particularly the continued decline in institutional asset management and growth in Managed Portfolios.
- Foreign-currency sensitivity, the concentration of liquidity outside the United States, and the variable-rate debt exposure.
- Resolution of the amended RICO litigation and ongoing tax audits, unrecognized tax benefits, and Tax Reform Act accounting.
- Use of the $500.0 million share-repurchase authorization; $489.5 million remained available as of June 30, 2018.